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A Model of a Double Standard Exchange Rate System

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  • Riku Kinnunen

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    (University of Liverpool)

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    Abstract

    In this paper I propose a "double standard" fixed exchange rate system which will be shown to have a higher expected lifetime than a conventional fixed exchange rate system. I present a simple variant of the classic Flood-Garber-Krugman model where the domestic currency is pegged to one of the two foreign currencies, depending on which exchange rate is lower; intuitively, this system thus corresponds to a gradual inflation stabilization program which will start at a future time that is determined by the foreign exchange market instead of the government. This type of a conditional peg implies that the domestic money holdings have a higher expected return as compared with the standard fixed exchange rate system. Since at each period there is a non-zero probability for the appreciation of the domestic currency, the demand for it is thus higher which decreases the probability of a speculative attack and increases the expected lifetime of the fixed exchange rate.

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    Bibliographic Info

    Paper provided by University of Liverpool Management School in its series Research Papers with number 2003_05.

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    Length: 10 pages
    Date of creation: 20 May 2003
    Date of revision:
    Handle: RePEc:liv:livedp:2003_05

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    Postal: Management School University of Liverpool, Chatham Street, Liverpool, L69 7ZH, Great Britain
    Phone: +44(0)151 795 3108
    Fax: +44(0)151 795 3004
    Web page: http://www.liv.ac.uk/management/
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    Related research

    Keywords: speculative attacks; fixed exchange rates;

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